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The 2011 Social Security Trustees Report — Harbinger of Bad News
The just-released 2011 annual report of the Social Security Trustees shows a significant worsening of the program’s finances.
Last year we were told that we would see payroll tax surpluses over benefit expenditures for a few more years — until 2015. That won’t happen according to the 2011 report; the program will now add to federal deficits in every future year — and increasingly so, which will ramp-up financial pressure to downsize other federal programs, increase taxes, or create yet more debt.
Note that both Republicans and Democrats negotiating over how to reduce federal deficits and the national debt have resolved to leave Social Security untouched for now. That leaves the program’s finances to fester and worsen — increasing the costs of future adjustments and burdens on future generations.
Many people, especially those who favor early reforms, say that the Social Security trust funds “don’t matter.” Note, however, that they lock up future federal revenues for Social Security benefit payments — on par with future dedicated payroll taxes.
The lock-up effect of the Social Security trust funds is demonstrated by the fact that the program’s cash flow deficits today are not forcing any benefit cuts or payroll tax increases. This can continue until the year 2036 according to the 2011 report.
But if we allow the situation to continue for that long, fixing the program will require a permanent benefit cut of at least 25 percent or a payroll tax increase of at least 40 percent of payrolls in 2036 and beyond.
Response to Joe Weisenthal’s Critique of My Politico Opinion Piece
Yesterday I had an op-ed in Politico suggesting that U.S. lawmakers should consider not raising the federal debt limit (at least for now). I argued that freezing the ceiling would assure investors that the United States is serious about reducing its debt, and that it would serve as a commitment device for lawmakers and President Obama to forge and follow a serious debt-reduction strategy.
A financial website writer named Joe Weisenthal strongly disagreed with my column. He seems to misunderstand several of the points that I was making, and so I offer the following response to his comments:
From Weisenthal’s post:
Another day, another economist advocating that the US default on its debt.
The latest is Jagadeesh Gokhale of the Cato Institute, who has a big piece advocating an immediate freeze of the debt ceiling.
It’s so convoluted, we hardly know where to begin, but let’s just address a few sloppy parts.
Many knowledgeable federal officials, like Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke, as well as left-leaning lawmakers, insist that the answer lies in lifting the debt limit. They warn Congress about the dire consequences if it fails to do so. President Barack Obama has chimed in — though he voted against raising it when he was a senator.
They all assert that failing to increase the debt limit could sharply undermine the economic recovery.
But that view could be wrong. A temporarily frozen debt limit could instead signal U.S. lawmakers’ resolve to get our fiscal house in order. It may even reassure investors about long-term U.S. economic prospects.
This line about “reassuring investors” is nonsense. Investors are already reassured, which is why interest rates have only fallen amidst all the squawking from the political class about this “crisis.”
From the start, Weisenthal doesn’t follow my argument. I am not concerned about the state of market confidence today, but what it would be if the debt limit were frozen. The contrarian view that I expressed in my op-ed is that participants would interpret a debt-limit freeze positively, just as they appear to have interpreted the recent downgrade of the U.S. economic outlook by Standard and Poor’s positively — U.S. equities, U.S. treasuries, and the dollar are up less than 48 hours after S&P’s downgrade announcement.
He also misunderstands why interest rates have declined. It is because of the Federal Reserve’s sustained intervention in bond markets, not because there is little investor concern over the United States’ long-term fiscal outlook.
When Too Much Money’s the Problem…
Last Friday’s PBS NewsHour included a debate between NYT columnist David Brooks and WaPo columnist Ruth Marcus on the budget fights on Capitol Hill. Marcus was sitting in for NewsHour regular Mark Shields, whose comments I find thoughtful and worth contemplating. Unfortunately, on Friday Marcus didn’t meet Shield’s standard.
In discussing House Budget Committee chair Paul Ryan’s proposal that Medicaid be converted to a block grant program with the states taking a broader administrative role, Marcus offers:
RUTH MARCUS: The cuts in here are so dramatic. They are so painful. And they — and many of them are focused — I know this is not his intention, but he turns, for example, Medicaid, which is the health-care program for poor people, into a block grant. You give it to states.
But then it just doesn’t grow enough to deal with the increase in health-care costs. Well, what happens to these people?
Is she serious!?
Marcus seems not to understand that government subsidies to health care consumption, in the form of such programs as Medicare and Medicaid as well as employer tax exclusions for health insurance benefits, contribute to the rapid growth in health care costs. That is, by flooding the health care market with government money, the market ends up with many dollars chasing few worthwhile health care products, which results in rising health care prices. Moreover, the subsidies siphon away health care resources from the private-payer health care market, causing cost in that sector to increase rapidly as well.
Subsidies aren’t the only government policies contributing to rising health care costs. Government restrictions on the supply of health care services also play a role. Among those supply restrictions are the ban on drug importation, a very costly and difficult new-drug testing regime, and unnecessarily restrictive licensing of health care professionals.
The rapid rise in health care costs is primarily the consequence of government policies. For Marcus to say that we should maintain the current subsidy system for health care because, without it, Medicaid patients won’t be able to keep up with health care cost increases is … well … not very good commentary.
Why Should Social Insurance Reform Not Affect Those Over Age 54?
House Budget Committee Chairman Paul Ryan’s budget plan is ostensibly for FY 2012, but it contains reforms with far-reaching implications for the nation’s fiscal condition.
Most of the action in his plan is on the spending side and mainly on health care entitlements: Medicare and Medicaid. Many pundits on the left are claiming it is a political document rather than a serious budget proposal, especially because it lacks details on many of its proposed policy changes.
One thing that stands out, as pointed out by David Leonhardt in the NYT, is that Ryan’s plan exempts people older than age 55 from bearing any share of the adjustment costs. They should, instead, be called upon to share some of the burden, Leonhardt argues — a point that I agree with. If seniors are receiving tens of thousands of dollars more than what they paid in for Medicare, then they should not be allowed to hide behind the tired old argument of being too old to bear any adjustment cost. Indeed, seniors hold most of the nation’s assets and a progressive-minded reform would ask them to fork over a small share to relieve the financial burden that must otherwise be imposed on young workers and future generations.
The numbers presented by Leonhardt are computed by analysts at the Urban Institute. However, those numbers aren’t quite as one-sided as Leonhardt and Urban scholars suggest, because they only compare Medicare payroll taxes by age group to Medicare benefits. A large part of Medicare benefits (Medicare’s outpatient care, physicians’ fees, and federal premium support for prescription drugs) are financed out of general tax revenues, not just Medicare taxes. General tax revenues, of course, include revenues from income taxes, indirect taxes, and other non-social-insurance taxes and fees. Seniors pay some of those taxes as well — especially by way of capital income and capital gains taxes — but the Urban calculations fail to account for this. That means that the net benefit to seniors from Medicare is smaller than Leonhardt claims in his column. I don’t know whether it would bring the per-person Medicare taxes and benefits as close to each other as they are for Social Security, however. (See Leonhardt’s column for more on this point.)
Leonhardt also notes that Chairman Ryan’s proposal leaves out revenue increases as a potential solution to the growing debt problem. Leonhardt argues that wealthy individuals (mostly large and small entrepreneurs) received high returns on assets during the last few years (pre-recession) and could afford to pay more in taxes.
But it would be poor policy to raise these entrepreneurs’ income taxes — that would distort incentives to work, invest, innovate, and hire in their businesses. Instead, policymakers should consider reducing high-earners’ Medicare and Social Security benefits (premium supports under the Ryan plan) in a progressive manner, including allowing them to opt out of Medicare and Social Security completely if they wish to.
During recent business trips to a few Midwestern towns, I met several investors and professionals in real estate, financial planning, and manufacturing concerns, most of whom expressed their willingness to forego social insurance benefits during retirement. So there seems to be some public support for such a reform of social insurance programs.
Debt Commission Reform Proposals – What Are Their Chances?
It’s kudos to President Obama’s Debt Commission co-chairs for clearly outlining the gargantuan size of the fiscal problem facing the United States. The reforms will re-direct the exploding debt trajectory downward by reforming taxes and cutting spending – reminiscent of recent fiscal reforms in the United Kingdom. Unfortunately, history is likely to repeat itself: Even if they are enacted soon — which seems unlikely — chances are bleak that we’ll stick with them for long enough to achieve their stated goals.
The Debt Commission co-chairs have done a stellar job in framing the nation’s fiscal challenge and placing it squarely before the American public. The contrast between the current trajectory that increases the national debt beyond 80 percent of GDP by 2040 and one of declining debt under their reforms likely to be consistent with long-term economic growth because the Commission also proposes limiting government spending to 21 percent of GDP — is striking.
The Commission has marked wide-ranging reforms — to broaden the federal tax base, reduce income tax rates and simplify the tax system; cut discretionary expenditures that are unaffordable and antiquated in all spheres; reduce long-term health care cost growth, and restore Social Security to financial solvency through a combination of benefit cuts and revenue measures.
It’s sad but true that the political barriers stacked up against this promising approach appear to be insurmountable. Given the make-up of Congress and with Obama as President, the chance that something even remotely resembling the Commission’s proposals would be enacted is negligibly small. With the Democratic majority in the Senate, President Obama is unlikely to even have to use his veto.
But what if my conjecture is proved incorrect and a roughly similar set of reforms is enacted in 2011? Remember that our fiscal problem is of a long-term nature. It is produced by an aging population; rapid health care cost growth; slower revenues from a flagging economy as a large cohort of experienced workers retires; slowing education and skill acquisition by younger workers; and slower capital formation as more resources are consumed by an aging population. The commission’s reforms have to be enacted and maintained for at least 30 years to deliver its “target” debt-to-GDP ratio of 40 percent. History tells us that such an outcome is quite unlikely. For example, the Budget Enforcement Act of 1990 — that helped President Clinton accumulate his now much touted laurel as a fiscal conservative — was maintained for just 12 years — until Congressional Budget Office projections revealed “budget surpluses as far as the eye could see” in 2002. With those projections in hand, lawmakers raced to the exits: the BEA was abandoned and federal spending shot through the roof. Even as conservative a policy maven as Alan Greenspan shone a green light to adopt budget busting tax cuts.
To improve the chances that history does not repeat itself, the commission’s proposals need to be combined with proposals to reform the budget process. The first thing to consider on that score is to use better budget measures to assess if reforms are achieving their goals. Stating those goals in terms of the national debt and annual cash flow deficits is unlikely to work – just as those measures have not worked for the European Union in the context of their now defunct Stability and Growth Pact.
Federal debt and the current budget deficit that is reported on the government’s books is the result of past policies and outcomes. They summarize where we came from, not where we’re going. If the commission’s reforms are enacted, a better method would be to anchor judgment about their success on the size of prospective debt—the value in today’s dollars of all future deficits that the federal government would incur under the new policies; alternatively under premature abandonment of those policies – as happened in 2002 when the BEA was abandoned. It is also important to know whether the sacrifices that the commission’s policies require from today’s generations are fairly distributed and are being invested for the future rather than being dissipated. For example, will the Social Security surpluses that the reforms generate be effectively saved and invested, or would they promote additional government spending as in the past? Without a budget process that delivers real investments for the future, and without metrics to measure their operation properly, chances are that even if Congress and the President enact them into law next year, the reforms will be abandoned too soon.
The Correct Perspective on Social Security Privatization
In today’s WSJ, William Shipman and Peter Ferrara have a column criticizing President Obama’s recent and vehement rejection of Social Security private accounts. I agree with Shipman and Ferrara — it’s rather shabby logic from a president of all Americans.
Shipman and Ferrara correctly note that Social Security privatization options provide participants with a choice — opt for private accounts or stay with the traditional system. In other words, people can choose their preferred risk set — political or market. The lesson here is that there’s no avoiding risk.
Shipman and Ferrara suggest that all investments in private Social Security accounts do not have to be in stocks; people can choose bonds as well. Better yet, they can hold the market basket of all stocks and bonds through low-cost index funds and hold some cash. They can select the mix between these elements to optimize the risk-return trade-off given their abilities/preferences on the two. This investment strategy is transparent and easy to learn; it requires only a modicum of financial literacy.
However, I find their ”Joe the Plumber” example unpersuasive. Who cares if investing on the planet Mars yields 50 percent annual returns if we cannot do it unconditionally — that is, without incurring costs that would neutralize its higher-than-Social Security returns? Those additional costs arise from having to borrow to pay existing Social Security beneficiaries their “promised” benefits, and from carrying market risks on personal account portfolios of Martian investments.
Market risk represents a real cost, even if investments are for the long term. The Shipman/Ferrara calculations take account of the recent financial crisis. But they don’t take account of the potential for fat tails in the distribution of financial crises going forward. The recent crisis could have been less severe. But what if it had been more severe and had wiped out all savings for many more people? Is there zero risk of such an outcome? A generalization on the basis of just one 40-year record of investment returns is inappropriate and insufficient for ruling out the importance of market risk.
Liberal Dogma on Social Security Redux
Liberal posturing on Social Security reform continues unabated – betraying nervousness that Obama’s Deficit Reduction Commission will recommend Social Security benefit cuts.
Left-wing voices also continue to repeat the mantra that introducing private Social Security accounts would be a bad idea. Ronald Brownstein’s recent recent column in the National Journal is a case in point. However, Brownstein’s readers may come away thinking that he believes breaking promises is a good idea.
Brownstein concedes that “Social Security indeed faces a long-term imbalance between expected revenue and promised benefits.” I consider this to be progress — at least relative to the erstwhile “there’s nothing wrong and nothing to fix” mantra adopted by liberal adherents of the status quo on Social Security.
Notice Brownstein’s use of the term “promised benefits.” A promise implies a commitment and obligation to make good on future benefit payments. But the solution that Mr. Brownstein points to is as follows:
Instead [of private accounts], Obama argued, the two parties could emulate the Reagan model and arrive at a sensible solution… [T]he program’s long-term shortfall could be eliminated just by trimming benefits for the top half of earners [JG note: breaking the Social Security benefit promise here], linking the retirement age to lengthening life spans [JG note: breaking the promise here too], and imposing a partial payroll tax on earnings above $250,000 [JG note: that is, promise more benefits by expanding the definition of covered earnings and increasing payroll taxes on high earners].”
But all that the last element may achieve is to stave of the program’s insolvency for a few more years.
My comment: Please don’t drag Reagan into this “solution.” The 1983 reforms were implemented under the gun, at a time when there was no way out of Social Security’s imminent revenue shortfall. If President Reagan had enjoyed the luxury of a couple more years to plan changes to Social Security, he would have adopted a different approach, and be much better off today. According to broad market indexes such as the S&P 500, total returns averaged well above 10 percent per year during the 1980s and 90s – so, well above inflation. (The first decade of the 2000s yielded a negative 1 percent return.)
The State of Social Security: Maybe a Little Better, Maybe a Little Worse?
The Social Security Trustees released their annual report yesterday, showing a small improvement in the system’s finances over the long-term. That’s rather surprising given that the recent recession has reduced the program’s revenues and brought forward the date when the program begins to drain money from the general budget — from 2016 last year to 2015 in the new report. The Trust Fund exhaustion date is 2037, the same as it was in last year’s report.
The new health care law is likely to increase the program’s revenues as employers reduce payroll-tax-free health insurance coverage and offset the reduction in employee compensation through higher wages that would be subject to payroll taxes. This sets up a competition between the health care law–induced increase in Social Security revenues and declines in revenues and increases in outlays for other reasons — a sluggish economy, improving longevity, the addition of another year at the end of the 75-year projection horizon, and changes in economic and demographic data, assumptions, and methods.
The positive revenue effect of the health care law (14 basis points) more than offsets the negative effects of all of the other factors (6 basis points) on the system’s long-range actuarial balance. That yields a total improvement of the program’s actuarial balance from –2.00 percent of taxable payroll to –1.92 percent. In next year’s report, however, this year’s “legislative” effects may be folded into changes from technical adjustments and incoming data. We may never know whether today’s assumptions on the revenue effects of the health care law are correct or not.
It could be that those assumptions are too large, especially if Congress postpones the tax on Cadillac health care plans because of pressure from unions. It could also be too small if many employers decide to eliminate health insurance coverage and opt to pay the less costly penalty. On balance, I’ve concluded that, faced with such wide uncertainty about future outcomes, the Social Security trustees have chosen to be relatively conservative in their estimates of the health care law’s revenue effect.
Another curious item is that the program’s long-range imbalance increased from $15.1 trillion to $16.1 trillion. However, the report states that “the near-term negative effects on employment of the slightly deeper recession than assumed last year are offset by higher than expected real growth in the average earnings level” (Section D: Projections of Future Financial Status). As a result, the program’s total (infinite-horizon) imbalance ratio declines from 3.4 percent in 2009 to 3.3 percent today.
Note that a deeper recession and higher unemployment than was assumed last year does not necessarily justify a correspondingly faster recovery, with unchanged long-term equilibrium unemployment and earnings growth rates. The trustees are discounting the possibility that the unemployment rate may remain higher than was assumed last year and that, therefore, earnings may not rebound any faster compared to last year’s assumptions. It appears that that incoming data on unemployment and GDP growth played little if any role in informing assumptions about future earnings growth rates.
Finally, it should be noted that this year there were no public trustees to oversee and modulate the report as it was being produced.
Deflation
I was listening to NPR in the car yesterday, when a report came on about the implications of deflation — which apparently is the latest concern regarding financial markets. The report nearly made me fall out of my seat from bewilderment and frustration.
Adam Davidson, the NPR reporter, waxed eloquent about how deflation turns normal economic and investment calculus on its head. But his explanation was so poor that he ended up saying exactly the opposite of what he should have said.
Here’s how it went for me:
Davidson: “Ladies and gentlemen, I have an amazing investment opportunity for you. Give me $100, just a hundred, and in one year I promise it will be worth 93 bucks. We call it the deflation special.”
My reaction: No, sir! Under deflation, $100 today would increase in value to $107 (assuming your implicit rate of deflation). Help! Stop the car! …Wait, I’m the one driving…what just happened?
Davidson: “All right, seriously, nobody is giving anybody a hundred bucks just so they can lose seven.”
My reaction: No, no, please, please take my money! I’d give you a million dollars if I had that amount. I really would!
Davidson: “That’s the opposite of an investment opportunity, which is precisely why economists and central bankers get terrified when they hear the word deflation.”
Social Security Bloviate-fest
The annual bloviate-fest on Social Security has begun, even before the Social Security Trustees’ report has been released this year. Apparently the report is to be released next week — after a three-month delay from its statutory release deadline of April 1.
There’s concern from groups interested in preserving Social Security that President Obama’s National Commission on Deficit Reduction will propose changes to the program involving benefit cuts. These groups, which include the AFL-CIO, MoveOn.org, NOW, and the NAACP have issued and allegedly rebutted five “myths” about Social Security. But their selection of myths and myth-busting arguments are weak and involves questionable arguments.
Below is a list of the twisted logic that these groups are using to convince voters that all’s well with Social Security’s finances and that we should not worry and just be happy. Also below are my reactions to the “faux-myth-busters” arguments.
Myth #1: Social Security is going broke.
Reality: There is no Social Security crisis. By 2023, Social Security will have a $4.6 trillion surplus (yes, trillion with a ‘T’). It can pay out all scheduled benefits for the next quarter-century with no changes whatsoever. After 2037, it’ll still be able to pay out 75% of scheduled benefits — and again, that’s without any changes. The program started preparing for the Baby Boomers’ retirement decades ago. Anyone who insists Social Security is broke probably wants to break it themselves.
Real Reality: We’re in a vortex, and these folks refuse to extend help. Yes, I also don’t like the “crisis” terminology. A better descriptor is “vortex,” the upper reaches of which can seem calm, for a time. But eventually, we’ll realize that what we thought was a good place to be is really an inexorable path to the doom of being spun around super fast.
Yes, Social Security will have a surplus (of Treasury IOUs) of $4.6 trillion by 2023. But, notwithstanding the “T” attached to that sum, all’s not well. By 2023, the program’s net liabilities (the shortfall of future revenues relative to future benefit commitments under existing laws) will exceed $20 trillion (note, also with a “T”). Last I checked, 20 exceeds 4.6 by about four fold.
The fact that Social Security “will be able to pay” 75% of scheduled benefits after 2037 means we would have to impose a 25% benefit cut at that time if no adjustments are made earlier. It’s said that the natural human instinct for justice emanates from a simple thought experiment — of placing oneself in the shoes of the victims. In this case, it’s those poor future souls who would have to acquiesce to a 25 percent benefit cut. But they would be forced to do so only because the faux-myth-busting authors shrieked in horror when confronted with a much smaller benefit cut that would be required now to place the program’s finances on a sustainable course. Read the rest of this post »
Heating Up the Covert Generational War
My latest book Social Security: A Fresh Look at Reform Alternatives (available here) argues that it’s not just labor quantity — the number of employees who are accruing future Social Security benefits — that will determine the size of Social Security’s future imbalances (and, incidentally, those of Medicare, and the size of deficits for all of government), but also the quality of that labor — the value of the work those employees are doing.
Declining labor quality (as experienced baby boomers retire) will reduce taxable payrolls faster than is being projected by the Social Security Administration and the Congressional Budget Office. The result is even more beneficiaries receiving Social Security checks, and lower-wage workers who will be funding those checks.
In the book, I construct a detailed simulation of U.S. demographic and economic forces over the coming decades to estimate how much of a drag declining labor quality will exert on labor productivity, countering the effects of capital accumulation and technological advance.
Now James Heckman has coauthored a study suggesting that the same thing is happening in Europe, traceable in part to public policies promoting less use and low maintenance of worker skills through the early retirement incentives of their public pension, welfare, and health systems.
So it is quite clear how the developed world (Anglo-Saxon and mainland Europe) will spiral downward. We’ll all vote to “strengthen” social insurance systems (the U.S. health care “reform” this year being the latest example), only to further weaken incentives for the young to acquire skills, further erode the tax base, which in turn will promote the further “strengthening” of social insurance protections … and so on.
My old idea of a “covert generational war” is playing out before our very (but fully blind) eyes.
Two months ago, EU officials were even flirting with the idea of a cross-country crisis insurance institution — a European Monetary Fund.
One ironic element in the ongoing European crisis: Remember how the EU’s erstwhile Stability and Growth Pact included penalties on nations who exceeded the 3 percent fiscal deficit rule? Turns out, penalties must now be paid by the “successful” countries — mainly Germany and France — by coughing up the aid packages!
The Cost of Government Guarantees
John Kay’s column in yesterday’s Financial Times criticizes government guarantees to banks because they involve hidden but large costs. According to Kay:
- Such guarantees distort competition: sheltered banks outperform rivals not because of greater efficiency, but because capital becomes cheaper to obtain.
- Sheltered banks gain too-big-to-fail status, which creates barriers to entry for smaller, more efficient banks.
- Relief from business risk leads to more risk taking, AKA moral hazard.
- Cheaper private risk management incentives are reduced within and outside the bank.
Other kinds of government guarantees, such as social insurance, also involve large hidden costs. Social Security and Medicare’s guarantee of a paid holiday with medical care for the rest of retirees’ lives generates the same types of costs:
- Labor competition is reduced because the programs induce early worker retirements, which leads to higher wage costs, on average, and lower national output.
- Workers who believe they will receive Social Security and Medicare will engage in lower personal saving, which means less capital formation and lower economic efficiency.
- Retirement income guarantees induce riskier personal savings portfolios, AKA moral hazard.
- Guaranteed retirement income means poorer financial knowledge and poorer risk management.
And now, retiree political power is too big to fail as well!
How come when Kay writes about market distortions from government guarantees for banks, he gets published; but when I do the same about government guarantees for people, I get the cold shoulder from editorial page editors?
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